by Tim Gaumer.
As we all know by now, Brexit caught most investors by surprise and a wide variety of markets around the world experienced a sharp initial sell-off. But in the aftermath of Brexit, markets have behaved inconsistently. We’re going to spend most of this story examining the behavior of sell-side analysts and their reactions as company experts. But first, take a look at the FTSE 100 – an equity index of the largest companies in the U.K.
Exhibit 1. FTSE 100 Index
Brushing off Brexit
Try finding Brexit on this three-month chart. OK, I’ll make it easier by highlighting the day of the referendum vote. A market dip happens just after this, from June 23-27. This reaction was both shallower and briefer than some had predicted. By the close on June 29, the market had fully erased those losses and as of this writing, stands within a couple of percentage points of its one-year high, achieved about this time last summer.
Exhibit 2. U.K. Government Bond Yields
Bond and forex directions
In contrast, look at this U.K. government bond yield chart above. It’s barely off its lows. This looks like bond investors have priced in a recession.
In a similar fashion, the British pound sterling has barely bounced from its lowest cross against the dollar – and not just the low for the last three months, but for the last 30 years.
Exhibit 3. British Pound vs. U.S. Dollar
Who’s the “smart money?”
Some assert that fixed income investors are better at pricing in risk and macro fundamentals than equity investors, or as a typical fixed income manager might put it, “bond investors are smarter than stock investors.” Some might claim the same for foreign exchange traders. As a former equities guy, I take exception to that characterization. However, looking at the major disagreements in the pricing charts above, it seems like somebody has it wrong.
For the remainder of this article, we’ll turn to the individual company experts. Sell-side analysts at the brokerage firms that cover U.K. stocks responded quickly to the vote for Brexit. Interestingly, they didn’t uniformly lower their forecasts. In many industries they did, but in others, they actually raised their opinions.
It’s informative to look at the changes in analyst sentiment at the industry aggregate level. For this study, we’re looking at analyst revisions for all U.K. companies at the Thomson Reuters Business Classification (TRBC) Industry Group level. This is a good compromise between looking at just 10 sectors and the more detailed industry level which may contain relatively few constituents.
Change in analyst sentiment is represented by the StarMine Analyst Revisions Model (ARM). ARM is a percentile (1-100) ranking of stocks based on changes in analysts’ estimates (typically EPS, EBITDA and revenue) and changes in recommendations for the current period, full year and next year. It also incorporates the Predicted Surprise, the percentage difference between the StarMine SmartEstimate® and the consensus estimate for each estimate measure and fiscal period combination. The key thing to keep in mind when looking at the table below is that the lowest numbers are most bearish and the highest ones most bullish.
Here, we show the dozen industry groups with the most negative changes in analyst sentiment, in ascending order. Displayed in the column next to the aggregated ARM scores are the aggregate price changes over the last four weeks. Notice that in many cases, there’s strong positive correlation – the market and analysts are in agreement, here’s where the largest negative impact from Brexit is expected to occur. These include homebuilders, airlines and banks.
Exhibit 4. StarMine ARM Scores
Spotlight on transport
As an example, let’s take a look at Passenger Transportation Services. This industry group is comprised mostly of airlines. For those of you with access to Eikon, clicking the number 18 under its ARM rank takes you to this details page.
Exhibit 5. Transportation Services
It’s not hard to imagine that Brexit might increase things like landing fees and make quick weekend jaunts back and forth between the Great Britain and the continent more inconvenient and expensive on both sides of the Channel. And, over the near term, the roughly 10% devaluation of the pound just made jet fuel more expensive. Oil trades globally in U.S. dollars. The most highly weighted constituent in this industry group is International Consolidated Airlines Group (ICAG.L), parent of BA. In the ARM view below, red boxes indicate a more negative outlook.
Exhibit 6. ICAG ARM Scores
The negative Predicted Surprise for this year can be seen in this Detailed Estimates view below. The SmartEstimate® quickly plunged below consensus and remains 5.5% below it, as a number of analysts who cover this airline have yet to revise their estimates. The SmartEstimate® puts more weight on the more recent estimates and the more accurate analysts and is highly predictive of the direction of future revisions.
Exhibit 7. ICAG Detailed Estimates
Returning to the Aggregates Report, but this time sorting in descending order, we see that for some industry groups, analysts actually raised their outlooks and again, the market roughly followed along. Here are the top few industry groups.
Exhibit 8. Upward Analyst Revisions
It seems like most of these can be explained by what happened to currencies. In the aftermath of Brexit, the pound weakened and money rushed to “safe havens” like the U.S. dollar and Japanese yen. So, for U.K. exporters, their goods suddenly became more price-competitive in the global marketplace. And for industries such as oil & gas, where the output is traded in U.S. dollars, a barrel of oil now buys 10% or so more pounds. This will add a few pence to EPS for London traded oil exporters. Still others on this list might be explained by either their low exposure to the EU and/or by the defensive nature of their goods and services. Industries such as food & tobacco, utilities, beverages and pharmaceuticals may fit that bill.
So, has the market, represented by the FTSE 100, been too hasty in shrugging off the potential ramifications of the referendum vote? Of course, it’s impossible to say, except in hindsight. In part, the vote in favor of Brexit has been claimed by some as a rejection of the “experts” of which Brexiters believe the world has too many. But looking at the “votes” by forex experts, fixed income experts and sell-side company analyst experts, the answer to “too hasty?” might well be “yes.”